Investigating Cost Behavior With Community Social Capital - Essay Sample

Abstract

In this study, we examine the impact of community social capital on asymmetric cost behaviour. Community social capital captures the strength of social norms and the density of social networks in a region. As such, it is a socio-economic factor that might affect managerial resource adjustment decisions via different channels. We find that firms headquartered in U.S. counties with high social capital exhibit significantly less asymmetry in cost behaviour. Community social capital restrains managers from taking opportunistic resource adjustment deci- sions that would induce cost stickiness. This is in line with our additional finding, that cooperative norms acting in an ethical manner are the dominant channel for our setting, by which community social capital affects cost behaviour. Our results corroborate the important role of managerial discretion in cost behaviour and make a significant contribution in understanding how local environmental factors explain differences in firms' sticky cost behaviour.

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Introduction

A growing body of academic literature documents that corporate and managerial decisions do not emerge in a societal vacuum, but that they are influenced by the social environment (Nahapiet and Ghoshal, 1998; Droege and Hoobler, 2003; Hasan et al., 2017a,b). In this study, we examine the effect of social environmental factors on asymmetric cost behaviour (also referred to as cost stickiness), a well-documented result of managerial discretion in the development of corporate cost compared with changes in a firm's activity.

We consider social environmental factors by adopting the commu- nity social capital concept, which is defined as the strength of co- operative norms and the density of networks in a region (e.g., Putnam, 1995). Cooperative norms are social norms that prevent individuals from acting opportunistically. Dense social networks facilitate social interactions and increase the level of social punishment for mis- behaviour associated with the cooperative norms' prescribed values (Coleman, 1988). Accordingly, community social capital is a socio- economic concept based on an idea that the level of opportunism, social interaction or trust in others can vary across different regions within a larger cultural framework (Coleman, 1988; Portes, 1998). As such, it has been the subject of extensive research in sociology (e.g., Coleman,1988), political science (e.g., Woolcook, 2010), as well as economics (e.g., Guiso et al., 2004) and "offers enormous potential for better un- derstanding multilevel management and organizational phenomena" (Payne et al., 2011, 492).

Cost stickiness describes the phenomenon that managers react quickly by expanding resources when sales are increasing, but are re- luctant to reduce redundant capacity when demand is decreasing. Hence, in general terms, costs increase more than they decrease for an equivalent change in firm activity. Accounting literature reveals con- siderable interest in understanding the determinants and differences in the levels of cost asymmetry. The vast majority of research studies in this area focus on firm-level determinants. In particular, adjustment costs (e.g., Anderson et al., 2003), managerial optimism (e.g., Banker et al., 2014) and opportunistic managerial motives (Chen et al., 2012) have been identified as the key drivers of asymmetric cost behaviour. Contemporary research is beginning to focus on country-level de- terminants. For example, Banker et al. (2013) find that formal institu- tional settings, such as employment protection laws, have an impact on cost behaviour. Kitching et al. (2016) are the first to consider informal institutions and provide evidence for the effect of national culture on managerial cost decisions.

We examine whether community social capital as an environmental

Part of this research was conducted while Loy was affiliated with the University of Nebraska-Lincoln. We thank James N. Cannon, Henri Dekker (editor), Yue Li, Raj Mashruwala (discussant), Joel Owens, Scott Seavey, Orestes Vlismas, two anonymous referees and seminar participants at the AAA 2018 MAS Midyear Meeting and the 41st Annual Congress of the EAA for valuable comments and suggestions. All errors remain our own.

Factor affects cost behaviour. Social capital might affect cost behaviour via different channels. First, it limits opportunistic behaviour. This is in line with contemporary literature which finds that managers of firms headquartered in high social capital regions behave less opportunisti- cally by being less engaged in earnings management (Jha, 2017) or tax avoidance activities (Hasan et al., 2017a), but more committed with regard to corporate social responsibility (Hoi et al., 2018). Since op- portunistic managerial behaviour is a determinant of cost asymmetry, we expect a negative relationship based on this argument. More spe- cifically, community social capital restrains self-centred resource ad- justment decisions by opportunistic managers, which in turn mitigates cost stickiness.

However, community social capital also increases the level of social interaction and mutual trust in a region. Stronger social ties between managers and their staff, together with altruistic managerial behaviour, have a significant bearing on corporate employment decisions and employee turnover (Leana and van Buren, 1999; Droege and Hoobler, 2003). Consequently, social capital might increase adjustment costs, which would prevent managers from adapting capacity when demand is decreasing, resulting in greater cost stickiness. Furthermore, executives in high social capital regions tend to be more optimistic (De Carolis and Saparito, 2006), which leads them to overestimate future demand and not adjust costs in line with contemporaneous activity. Based on these arguments, we predict a positive association between cost stickiness and community social capital. In summary, we conjecture that com- munity social capital, as an environmental factor, affects managerial cost behaviour choices, but opposing forces result in two competing hypotheses.

To analyse the relation between community social capital and cost behaviour, we exploit variations in the level of social capital across different U.S. regions by adopting an established social capital measure at county-level from Rupasingha et al. (2006). Employing a sample of 52,870 firm-year observations across 776 U.S. counties, we find that community social capital has a significantly negative impact on asym- metric cost behaviour. This is in line with our first prediction that social capital seems to restrain managers from taking self-centred, opportu- nistic resource adjustment decisions that would induce cost stickiness. The observation is also economically meaningful. Managers of firms located in high community social capital counties cut costs by 6.6 percentage points more than their counterparts in lowest social capital regions. The general cost stickiness level for firms headquartered in high social capital regions is 5.4 percentage points lower than that of firms in low social capital regions. Indeed, firms located in high com- munity social capital areas do not seem to exhibit any sticky cost be- haviour.

This main result is also consistent with our finding that social norms prompting behaviour in a morally expected manner comprise the dominant channel in our setting, by which social capital affects cost behaviour. We further provide evidence that empire building incentives exhibit a significant association with cost stickiness only in low social capital counties. Moreover, proxies for good governance, such as more independent directors, also seem to have a significant impact on op- portunistic cost behaviour only in low social capital counties. In this regard, corporate governance and community social capital seem like substitutes for each other. Our results are further corroborated by several sensitivity tests. For instance, the results are generally un- affected by different cost (sub-)categories and stable across geo- graphically (un-)diversified firms.

Our findings contribute to the literature on cost behaviour that examines differences in the degree of cost stickiness across firms by introducing a new concept, which combines sociological and manage- ment accounting research. Kitching et al. (2016) document that en- vironmental factors such as culture can affect cost behaviour decisions.

The remainder of this study is organised as follows. Section 2 pro- vides the theoretical background and hypotheses development. Section 3 explains the research design and describes our sample. Section 4 presents the main empirical results, which we critically discuss in Section 5. Section 6 concludes.

Background and Hypothesis Development

Asymmetric Cost Behaviour and Managerial Decisions

One of cost accounting's basic principles is the division into either fixed or variable costs. Whereas fixed costs, at least in the short run, remain stable, variable costs react to changes in firm activity. The traditional model of cost behaviour assumes a symmetrical relationship between variable costs and activity changes (e.g., Noreen, 1991). Thus, managerial decisions do not play an important role in this traditional view. However, a growing body of evidence contradicts this assump- tion. It is well-documented that managerial discretion can lead to asymmetric cost behaviour. Managers are quick to expand resources when demand is increasing, but for a variety of reasons choose to 'stick' with unutilised capacity when sales are decreasing. Consequently, costs increase more than they decrease for an equal change in activity (Anderson et al., 2003). This phenomenon has been labelled cost stickiness.

The drivers of asymmetric cost behaviour are manifold, but can be divided into three main categories (Banker et al., 2018). First, when sales decline, managers trade-off benefits and costs of adjusting or holding unutilised resources - generally, the higher the adjustment costs, the lower the willingness to cut costs and reduce capacity. La- bour-related aspects make up a major component of overall adjustment costs, which include monetary factors such as severance payments for dismissed employees or integration costs such as training for those newly hired. However, particularly in the long-term, managers also consider non-pecuniary, indirect costs such as lower staff morale or the loss of reputation (Anderson et al., 2003).

Second, when weighing adjustments against holding costs, man- agers also consider their (subjective) estimation of future demand conditions. Thus, there is an increased likelihood that managers with greater optimism and confidence will overestimate future demand. They 'sit out' the - in their view - hopefully short-term downturn in order to avoid additional costs of recovering the original capacity after do...